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Failure to keep proper records and comply with Companies Act - Directors and shareholders ordered to pay $140,000 to company

30 May 2016

There will be many farmers, particularly dairy farmers, struggling in the current economic climate. Some farming companies will be sailing close to the wind by continuing to trade where they may be almost insolvent. Some may eventually fail and be put into liquidation. If that is the case, the liquidators will examine the company’s business activities and records to determine whether they can recover any money from the directors or shareholders.  A recent case (Madsen-Ries v Petranz Limited (in liquidation) [2015] NZHC 538) illustrates the consequences that can arise if directors do not follow correct legal processes and do not keep proper records.

Liquidators’ successful claim

Petranz carried on business as a cartage company. It was placed into liquidation by IRD. Petranz's liquidators made several claims against the sole directors and shareholders of the company (Mr and Mrs Petera). One of these claims was for the recovery from Mr and Mrs Petera of company funds paid out before the company went into liquidation.

The liquidators produced evidence to the Court that the Peteras had purchased groceries, takeaways, clothing and liquor with company funds; they had withdrawn cash from the company’s account and had used the company’s funds to pay their mortgage. The Peteras argued that many of these payments were for business purposes. However, the judge did not accept this argument because the Peteras could not produce any documentation to show that the payments were business-related.

The Peteras also argued that some of the payments were made to them for salaries and wages. The judge did not accept this argument either. The judge pointed to the fact that other payments had been made to the Peteras in the nature of salary and wages and these had been declared. The judge also referred to section 161 of the Companies Act which authorises directors of a company to pay remuneration or benefits to a director provided the payment is fair to the company and the directors sign a certificate to this effect. The directors must also ensure that the payment is noted in the company’s interests register. If the directors do not sign the certificate or do not have reasonable grounds to believe the payment is fair to the company, then they will be personally liable to the company to repay the amount to the extent they cannot prove that the payment is fair. Mr and Mrs Petera had not complied with s 161 and acknowledged that they had not turned their mind to this requirement. The judge noted that, even if Mr and Mrs Petera intended the payments to be wages and salary at the time they were made, they had not been classified as such then and could not be treated in this way now.

As a result, the judge found that the Peteras had taken $140,000 of the company’s money for their own purposes. This money would be treated as drawings which increased the Peteras’ current account balance. As there was no documentation to show otherwise, the withdrawals were owed by the Peteras to the company as a debt repayable upon demand.

In respect of the salary and wages that had been declared, the judge found that the payments were fair. The liquidators could not therefore recover them under s 161 even though the Peteras had not followed the correct procedure under that section. Reasons for the judge’s conclusion were that Mr and Mrs Petera had paid PAYE on the payments and had given full value for the payments by working long hours in the business.

A lesson from this

If Mr and Mrs Petera had kept proper records they might have been able to show that some, if not all, of the payments were for business purposes. That would have meant they would not have been ordered to repay these amounts to the company. They might have documented the terms of repayment of their current accounts so that they were not repayable upon demand.  Finally, if the Peteras had complied with the Companies Act in respect of the payment of remuneration to them, they might not have had to justify to the Court that the remuneration was fair in order to keep it.

It is obvious that keeping proper business records and complying with the Companies Act is the best way to carry on your business. If you are not sure what your legal obligations are you should take professional advice.

 

Please email me at barbara.mcdermott@nwm.co.nz with your ideas for future articles. Keep an eye out for next month's column, where I will discuss another relevant rural legal issue.


Barbara McDermott is a partner of Norris Ward McKinnon, specialising in commercial and rural law. With offices in Hamilton and Huntly, we have friendly, expert legal advisors ready to help you with your business and personal legal matters.